Dow, S&P tumble to three-month lows

Outlook for inflation, interest rates cloud economic view

By

MarkCotton

NEW YORK (MarketWatch) -- U.S. stocks ended sharply lower Wednesday, with the Dow Jones Industrial Average and the S&P 500 Index tumbling to their worst levels in three months, as concern about inflation, the prospect of higher interest rates and slowing economic growth took the shine off a fresh pullback in crude-oil prices.

The Dow industrials
DJIA, +0.12%
closed down 123.75 points, or 1.2% at 10,317.36. The benchmark index has now fallen three days in a row, with Wednesday's session marking its biggest one-day decline since June 24.

American Express
AXP, -0.59%
was the only Dow component to end the session with a gain.

The S&P 500 Index
SPX, +0.23%
dropped 18.08 points to 1,196.39, the first time the broad gauge has ended below the psychologically key 1,200 mark since July 8.

For its part, the Nasdaq
$COMPQ
fell 36.34 points to 2,103.02, its biggest one-day decline in nearly six months.

"All sectors are getting hit because of inflation fears and the ominous tones coming out of the Fed," said James Park, director of institutional trading at Rodman & Renshaw.

On Tuesday, three regional bank presidents of the Federal Reserve warned that the central bank is likely to continue raising short-term interest rates to keep inflationary pressures in the economy at bay. See full story.

Sentiment took a further knock after a report showing a sharp slowdown in service sector growth, as well as a pickup in inflation in the sector.

The Institute for Supply Management's nonmanufacturing index fell to 53.3% from 65% in August. This is the lowest level since April 2003; the drop also was sharper than expected. Economists were looking the index to slip to 60.3%.

New orders fell to 56.6% from 65.8%. The price index rose to a record 81.4% from 67.1%.

"The ISM report did have a big impact on the markets, and part of the reason is that the economy is now more of a service economy," said Paul Nolte, director of investments at Hinsdale Associates. "And services are going to be much more directly and more immediately impacted by the higher energy prices we have seen." See full story.

On the broader market for equities, decliners outpaced advancers by around four to one on both the New York Stock Exchange and the Nasdaq.

Volume was heavy with 1.91 billion shares exchanging hands on the Big Board, while 1.95 billion were traded on the Nasdaq.

In the energy pits, crude futures ended lower for the fourth session in a row, as the latest Energy Department report showed a sixth weekly drop in inventories, but also a drop in demand for oil and refined products brought on by higher prices. Crude for November delivery ended down $1.11, or 1.7% at $62.79 a barrel. See Futures Movers.

On the currency markets, the dollar pulled back from multimonth peaks hit earlier in the week, as traders locked in gains sparked by rising expectations of further interest-rate hikes. Higher interest rates raise the attractiveness of U.S. denominated assets.

The euro was up 0.3% at $1.1959, helped in part by an upbeat services-sector purchasing managers survey that rose to its highest level in 14 months. See full story.

Against the Japanese yen, the greenback slipped 0.3% to 113.92. See Currencies.

Gold futures bounced off one-week lows to end unchanged for a second session as traders gauged inflation concerns. The benchmark December contract ended at $469.30 an ounce. See Metals Stocks.

On the bond market, long-term U.S. Treasury prices rose, sending yields lower, helped by the weaker than expected, post-Katrina reading for a measure of the U.S. service economy.

The market has gained since the benchmark 10-year yield hit a nearly two-month high on Monday, owed to continued inflation concerns. On Wednesday, the 10-year note finished up 4/32 to 99 4/32, adding about $1.25 in value for every $1,000 in securities. The yield ($TNX) fell to 4.36% vs. 4.38%.

Car sector in focus

The auto sector was in focus as General Motors Corp
GM, +1.70%
announced it was selling its entire equity stake in Fuji Heavy Industries Ltd., the owner of the Subaru car brand, to refocus its Asia-Pacific strategy toward high-growth markets.

The world's largest automaker, which is in the middle of a wrenching restructuring program, said cash proceeds received and any potential gain on the Fuji Heavy sale will be recorded in the fourth quarter.

Meanwhile, the Detroit News said that GM and the United Auto Workers are close to striking a deal that would save the company $1 billion in annual health-care costs. Shares of GM saw losses accelerate late afternoon, with the stock ending down 4.8% at $28.63. See full story.

Delphi Corp.
DPH, +0.00%
stock fell 10% to $2.50 as investors mulled a New York Times report, suggesting that the cash-strapped auto-parts maker will only avoid Chapter 11 bankruptcy protection if it can wring concessions from former parent GM and from the United Auto Workers' union. See full story.

Yum Brands Inc
YUM, -0.45%
rallied after the operator of Taco Bell, KFC and Pizza Hut fast-food outlets lifted its 2005 profit outlook in the wake of adjusted third-quarter results that topped analysts' estimates. The stock ended up 56 cents at $48.83. See full story.

It was a less rosy picture at fast-food giant Wendy's International
WEN, +0.61%
The hamburger chain posted a 5% drop in third-quarter same-store sales, and warned that Hurricanes Katrina and Rita coupled with higher beef prices would shave earnings for the period by 4 cents a share.

Wendy's, however, said that it would benefit from a fall in beef prices in the fourth quarter, helping the company erase early gains and trade up 61 cents to $47.33.

Broker calls

Harley-Davidson
HDI, +0.31%
shares fell $2.92 to $44.81 after the company was downgraded to sell from neutral at Bank of America, due to concerns over rising retail inventory and slowing demand.

Analyst Gary Cooper also believes the lackluster customer response to the motorcycle maker's 2006 models will lead to decline in wholesale unit shipments. Cooper lowered his stock price target to $36 from $53.

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